LIBERTY MUTUAL INSURANCE COMPANY v. VIKING INDUSTRIAL SECURITY INC.

NOT FOR PUBLICATION WITHOUT THE

APPROVAL OF THE APPELLATE DIVISION

 

SUPERIOR COURT OF NEW JERSEY

APPELLATE DIVISION

DOCKET NO. A-0

LIBERTY MUTUAL INSURANCE

COMPANY and LM INSURANCE

CORPORATION,

Plaintiffs-Respondents,

and

STATE OF NEW JERSEY,

Plaintiff/Intervenor-

Respondent,

v.

VIKING INDUSTRIAL SECURITY,

INC., VIKING ALARM SYSTEMS,

INC., RALPH DAY, SR., RALPH

DAY, JR., VIKING GROUP, INC.,

and VIRGINIA DAY,

Defendants-Appellants,

and

RICHARD GIRASOLE, C.P.A.,

Defendant-Respondent.

__________________________________

VIKING INDUSTRIAL SECURITY,

INC., VIKING ALARM SYSTEMS,

INC., RALPH DAY, SR., and

RALPH DAY, JR.,

Plaintiffs-Appellants,

v.

LIBERTY MUTUAL INSURANCE CO.,

PEROLA ANDERSSON, and RICHARD

GIRASOLE, C.P.A.,

Defendants-Respondents.

__________________________________

January 8, 2014

 

Argued December 11, 2013 Decided

 

Before Judges Fuentes, Fasciale and Haas.

 

On appeal from the Superior Court of New Jersey, Law Division, Somerset County, Docket Nos. L-525-07 and L-1223-07.

 

Eilish M. McLoughlin argued the cause for appellants (Law Offices of Charles Shaw, P.C., attorneys; Charles Shaw, Ms. McLoughlin and Romain D. Walker, on the briefs).

 

Jonathan M. Kuller argued the cause for respondents Liberty Mutual Insurance Co. and LM Insurance Corp. (Goldberg Segalla, LLP, attorneys; Mr. Kuller and Anthony J. Golowski, II, on the brief).

 

Joseph E. Snow, Deputy Attorney General, argued the cause for respondent State of New Jersey (John J. Hoffman, Acting Attorney General, attorney; Lewis A. Scheindlin, Assistant Attorney General, of counsel; Brian M. Brennan, Deputy Attorney General, on the brief).

 

Kenneth M. Dalton argued the cause for respondent Richard Girasole (Vaslas, Lepowsky, Hauss & Danke, LLP, attorneys; Mr. Dalton, of counsel and on the brief).

PER CURIAM

In this case of alleged insurance fraud, defendants Viking Industrial Security, Inc. (Viking Industrial), Viking Alarm Systems (Viking Alarm), Viking Group, Inc. (Viking Group), Ralph Day, Sr. (Day Senior), Ralph Day, Jr. (Day Junior), and Virginia Day (collectively defendants) appeal from two September 11, 2009 orders of the Law Division granting discovery sanctions against them and in favor of plaintiffs Liberty Mutual Insurance Company and LM Insurance Corporation (collectively Liberty Mutual) and intervenor State of New Jersey. As a direct result of these discovery sanctions, partial summary judgment was subsequently granted to Liberty Mutual and the State and, following a bench trial on damages and other issues, judgments were entered against defendants for damages, penalties, interest, and attorneys' fees. Defendants also challenge these judgments on appeal. Because we conclude the motion judge mistakenly exercised her discretion in imposing discovery sanctions which effectively required that judgment be entered in favor of Liberty Mutual and the State, when lesser sanctions would have been sufficient to level the playing field, we reverse and remand for further proceedings.

The procedural history and facts of this litigation are well known to the parties and we therefore summarize only the portions of the record pertinent to the discovery sanction rulings. The Viking companies provide security services to various business clients. Day Senior was the owner of the companies and Day Junior served as president. In June 2000, Viking applied to the State Compensation Rating and Inspection Bureau for workers' compensation insurance and the Bureau assigned Liberty Mutual to provide the coverage. Coverage premiums are based upon a company's payroll. Generally, the smaller the payroll, the lower the premium. In 2000, Viking reported approximately $500,000 in payroll to Liberty Mutual. The actual payroll in 2000 was between $2 and $3 million.

Over the next few years, Liberty Mutual conducted audits of Liberty's payroll records to determine the annual premium. Viking was represented in those audits by defendant Richard Girasole, a certified public accountant licensed in New York and New Jersey. According to Girasole, Day Senior proposed maintaining a "small" and a "big" payroll and showing Liberty Mutual only the small payroll in order to reduce the insurance premiums. Girasole initially balked at doing so, but agreed to do it in 2001 as a favor to his client. Girasole believed that Liberty Mutual would pick up the difference between the small payroll and the corporate tax return at the end of the year. However, Liberty Mutual never did. Thereafter, Girasole believed his office began giving Liberty Mutual the entire payroll for subsequent audits, but his staff "inadvertently" neglected to do so. As a result, Liberty Mutual continued to calculate Viking's premiums using only the small payroll.

At the end of 2004, the State Office of Insurance Fraud Prosecutor contacted Liberty Mutual and advised that an anonymous caller had alleged that Viking was not reporting its full payroll. Liberty Mutual conducted a lengthy investigation. During the course of that investigation, Girasole only provided the auditors with the small payroll and never disclosed that Viking maintained complete payroll records on QuickBooks, a computer program. Suspecting it did not have Viking's complete payroll records, Liberty Mutual estimated a new premium, which Viking failed to pay. As a result, Liberty Mutual terminated Viking's workers' compensation insurance policy on December 13, 2005.

Girasole then began to work with Liberty Mutual to determine the correct premium and, after discussing the matter with Day Senior, he provided both the big and small payrolls to the auditors. Viking and Liberty Mutual entered into an agreement under which the insurance would be reinstated on the condition that Viking pay Liberty Mutual $563,744, to be secured by a promissory note personally guaranteed by Day Senior. The note was executed on May 15, 2006. Viking made a few payments on the note, but it eventually stopped paying, leaving a $253,350 balance.

On March 29, 2007, Liberty Mutual commenced the current litigation against Viking Industrial, Viking Alarm, and Day Senior, alleging failure to pay the promissory note, failure to pay insurance premiums, and refusal to permit an audit of Viking's records. Defendants then filed a complaint against Liberty Mutual and one of its auditors, alleging that Liberty Mutual had wrongfully cancelled the policy. The two actions were consolidated. The State intervened, alleging insurance fraud in violation of the New Jersey Insurance Fraud Prevention Act ("IFPA"), N.J.S.A. 17:33A-1 to -30. Both Liberty Mutual and the State added claims against Girasole as a separate defendant, and defendants filed counterclaims against Girasole.

Liberty Mutual and the State sought discovery from defendants and asked for any payroll records maintained electronically by Viking. Viking maintained a "payroll module" on a QuickBooks program, which listed all of its payroll information, including hours worked, employee earnings, and deductions, including payroll taxes. Defendants did not provide these records and, indeed, stated throughout the next year that payroll records were not electronically maintained.

On October 17, 2008, the court appointed a special discovery master. Liberty Mutual complained that defendants were withholding information. Defendants alleged that they had answered Liberty Mutual's and the State's many discovery requests and asserted that much of the information they sought was in Girasole's possession.

In December 2008, over a year after Liberty Mutual had commenced this action, one of Viking's bookkeepers testified at a deposition about the QuickBooks account maintained by Viking. The bookkeeper testified that both Day Senior and Day Junior knew about the program and were able to operate it. Liberty Mutual filed a motion with the discovery master seeking to require defendants to produce the QuickBooks records. Defendants opposed the motion, asserting that Girasole possessed all of Viking's financial records. Day Senior also submitted a certification stating that he and his son were not proficient with QuickBooks.

The discovery master granted Liberty Mutual's motion and defendants produced a CD from the QuickBooks program. However, Liberty Mutual and the State were unable to open the CD to view the records. After the discovery master and the motion judge again ordered the production of the QuickBooks records, defendants provided another CD, but Liberty Mutual alleged that some documents were missing. The discovery master and motion judge then ordered that Liberty Mutual and the State should have direct access to the program. On April 20, 2009, the parties met at Viking's premises and the QuickBooks records were downloaded and printed. The records showed both the big and small payrolls, together with what Liberty Mutual's auditors called a "hidden payroll" of additional "employees," who were paid as independent contractors. Other revenue, expense and income information was also provided.

Liberty Mutual stated that it made "[e]xtensive use of those records . . . during the course of the depositions" of Day Senior and Day Junior. Liberty Mutual also gave the records to its "rebuttal damages expert, Shelly Brown, CPA" for review. In addition, Liberty Mutual immediately used the information contained in the QuickBooks records to raise new claims against defendants. On May 6, 2009, it filed a fourth amended complaint1 against defendants, alleging fourteen counts: failure to pay the promissory note; failure to pay premiums; a book account claim; quantum meruit; liability for refusal to permit an audit; workers' compensation fraud; insurance fraud in violation of the IFPA; common law fraud; aiding and abetting; declaratory judgment as to the parties' rights and obligations with respect to the cancellation of the policy; successor liability; fraudulent conveyance; civil conspiracy; and piercing the corporate veil.

In August 2009, Liberty Mutual filed a motion for discovery sanctions against defendants. The State joined this motion, which was opposed by defendants. Liberty Mutual and the State sought to recover their expenses and attorneys' fees caused by defendants' failure to turn over the QuickBooks records when they were initially requested. Again, defendants alleged that they relied upon Girasole to maintain their records, that the records were available through Girasole, and that neither Day Senior nor Day Junior were proficient enough with the computer program to retrieve the records sought by Liberty Mutual and the State.

Although Liberty Mutual and the State had obtained the QuickBooks records they sought, each also sought a "spoliation order" against defendants which would require, as a sanction for initially "hiding" and failing to disclose these records, that certain critical paragraphs of Liberty Mutual's fourth amended complaint relating to its workers' compensation, insurance, and common law fraud claims, "be deemed conclusively established herein, as to any dispositive motions and trial." The relevant paragraphs of the complaint which Liberty Mutual and the State sought to have "conclusively established" were as follows:

56. Liberty Mutual has ascertained that at all times relevant Viking maintained two separate sets of payroll records -- a "big" payroll and a "small" payroll.

66. Prior to and during the course of this litigation Viking, under the direction of Ralph Day, Sr. and Ralph Day, Jr. as well as Ralph Day, Sr. in his individual capacity, have falsely and intentionally maintained that Viking has no payroll records pertaining to the Liberty Mutual coverage periods.

74. The following, singly and/or in the aggregate, constitute statements, representations or submissions:

 

. . . .

 

g. The representation by Viking under the direction of Ralph Day, Sr. and Ralph Day, Jr., before and during this litigation, that Viking has no payroll records pertaining to the Liberty Mutual policy periods.

 

75. The statements, representations and/or submissions set forth in paragraph 74 above were false when made, in that, inter-alia:

 

. . . .

 

g. The statements and representations of Viking, under the direction of Ralph Day, Sr. and Ralph Day, Jr.; and of Ralph Day, Sr. individually that Viking has no payroll records relevant to the Liberty Mutual policy periods were and are false in that at all times relevant complete payroll records were maintained electronically at Viking via the "QuickBooks" software system and the "Payroll Module" of the said software system, as well as via hard copy including weekly payroll reports maintained in the office of Ralph Day, Jr.

 

81. Viking has purposely or knowingly made a false or misleading statement, representation or submission for the purpose of evading the full payment of premiums pursuant to R.S. 34:15-1 et. seq.

82. Ralph Day, Sr. has purposely or knowingly made a false or misleading statement, representation or submission for the purpose of evading the full payment of premiums pursuant to R.S. 34:15-1 et. seq.

. . . .

104. The following, singly and in the aggregate, constitute statements within the meaning of the fraud act.

 

a. The execution and submission of the Application, including the Employer Certification.

 

a.[sic] The statements, representations and documents presented to Auditor Lacorazza on August 2, 2002.

 

b. The statements, representations and documents presented to Auditor Lacorazza on August 11, 2003.

 

c. The statements, representations and documents presented to Auditor Lacorazza on August 12, 2004.

 

d. The undated letter from Girasole on behalf of Viking which was received on September 28, 2004.

 

e. The creation and maintenance of two sets of payroll records, directed by Ralph Day, Sr. and Ralph Day, Jr. and the presentation of only "small" payroll information, records and 941 forms to Auditor Lacorazza.

 

f. The representation by Viking under the direction of Ralph Day, Sr. and Ralph Day, Jr., and by Ralph Day, Sr., individually, before and during this litigation, that Viking has no payroll records pertaining to the Liberty Mutual policy periods.

. . . .

106. The statement(s) set forth in paragraph 104 knowingly contained false or misleading information concerning any fact or thing material to an insurance application or contract, in that, inter alia:

 

. . . .

 

g. The statements and representations of Viking, under the direction of Ralph Day, Sr. and Ralph Day, Jr.; and of Ralph Day, Sr. individually that Viking has no payroll records relevant to the Liberty Mutual policy periods were and are false in that at all times relevant complete payroll records were maintained electronically at Viking via the "QuickBooks" software system and the "Payroll Module" of the said software system, as well as via hard copy including weekly payroll reports maintained in the office of Ralph Day, Jr.

 

Liberty Mutual also requested that the court order "that a negative inference jury charge . . . be given against the Viking/Day parties with respect to any and all damage claims [raised by defendants against Liberty Mutual] herein, at trial." Liberty Mutual stated that it sought this sanction because the QuickBooks records were relevant to defendants' claims against it and were needed to defend against these claims. It bears emphasis, however, that at the time it sought these sanctions, Liberty Mutual had the QuickBooks records made extensive use of them in depositions and its trial preparation.

Finally, defendants had alleged in their complaint that Liberty Mutual's cancellation of the workers' compensation insurance policy caused it to lose a company called CSX as a customer. Liberty Mutual alleged that information found in the QuickBooks records demonstrated that CSX was not defendants' client at the time defendants' damages expert alleged it was. However, defendants continued to argue to the contrary. Despite having had the information available to address this claim, Liberty Mutual asked the motion judge to forbid defendants, as a discovery sanction, from asserting any claim regarding CSX.

Defendants argued that no spoliation had occurred. Although the QuickBooks records were not produced when initially requested, Liberty Mutual and the State now had them and there was no evidence that any of these records had been destroyed or altered. Therefore, defendants argued that Liberty Mutual and the State did not allege, and failed to demonstrate, any prejudice to their ability to prosecute their complaints or defend against defendants' claims.

After oral argument on September 11, 2009, the motion judge granted Liberty Mutual's and the State's motions and issued two "spoliation orders" granting all the discovery sanctions sought by them. In a very brief oral opinion, the judge stated:

I have been involved with this case for quite some time. I've had a discovery master in this matter due to the [protracted] length of the discovery in this matter and, as a result of all of the paperwork, of the discovery that's gone on for months, I have to agree with the plaintiff's, Liberty Mutual's assertion that, in fact, there was a calculated method of discovery misconduct by the Viking[/]Day parties.

 

. . . .

 

I think that the issue with the payroll records by Viking[/]Day, a large payroll and small payroll, which is at the center of this litigation with the Quick Books, the denial of access to the Quick Books, of knowledge of how to get into the Quick Books, the so-called passwords really just illustrate the enormous bad faith that has gone on and has been pervasive during the entire course of this litigation.

 

It has been argued . . . by Viking that it's of no consequence, that the Quick Books are available now, that it wasn't a big deal in reference to it, but there have been over ten occasions where documents have been asked for, ESIs [Electronically Stored Information] have been asked for, and that . . . Viking contended that they didn't have, that ultimately they did have.

 

The numerous discovery that was taken, the excellent investigation that has been done by Liberty Mutual and the other parties in this matter have shown without question that Ralph Day, Sr., Ralph Day, Jr., in fact, and Viking Security Corporation has really done everything in their power to impede the discovery in this matter and, as a result of that, -- and I incorporate the comments of Counsel in my decision - - I am going to grant in total the discovery sanctions and relief that have been asked for by the plaintiffs in this matter.

 

In addition to awarding counsel fees and costs to Liberty Mutual and the State, the judge also: (1) ordered that Paragraphs 56, 66, 74(g), 75(g), 81, 82, 104, and 106(g) were "deemed conclusively established herein, as to any dispositive motions and trial"; (2) ordered that "a negative inference jury charge shall be given against [defendants] with respect to any and all damage claims herein"; and (3) barred defendants from offering, "in opposition or in support of any dispositive motion or at trial any proof of damages or loss pertaining to former Viking customer CSX."

Liberty Mutual and the State thereafter submitted certifications of counsel in support of their applications for attorneys' fees and costs. On October 26, 2009, the motion judge granted Liberty Mutual $92,513 in fees and costs, with the State receiving $15,345. On January 8, 2010, the judge denied defendants' motion for reconsideration of the fees and costs awarded.

Armed with the spoliation orders, Liberty Mutual and the State next moved for summary judgment. After hearing oral argument on March 26, 2010, the motion judge found defendants liable for workers' compensation fraud, insurance fraud, and common law fraud based upon the spoliation orders.

The matter was scheduled for trial before a different judge to determine damages and the remaining unresolved aspects of the case. Liberty Mutual and the State then settled with Girasole.2 At the conclusion of the trial, the trial judge found in favor of Liberty Mutual and the State on all counts then in dispute and awarded them damages, interest, penalties, and additional attorneys' fees and costs. All of defendants' claims against Liberty Mutual and Girasole were dismissed. This appeal followed.

On appeal, defendants argue that the motion judge erred by entering the spoliation orders. They concede, as they must, that the QuickBooks records were not provided to Liberty Mutual and the State when they were requested. However, defendants argue that they were not solely responsible for the delay, and allege that the records were always obtainable from Girasole, who was a separate defendant in the case. They also contend that they could have proved that the Days were not as proficient with QuickBooks as plaintiffs alleged. Because the records were eventually provided, defendants argue that Liberty Mutual and the State were able to use them both in depositions and during their preparation for trial. Thus, defendants assert that the spoliation orders had the same effect as entering judgments for plaintiffs on the workers' compensation fraud, insurance fraud, and common law fraud counts. This was an unduly harsh sanction, especially since the motion judge did not consider whether lesser sanctions were appropriate. Because we agree that the motion judge mistakenly exercised her discretion in imposing a dispositive sanction, we reverse and remand for further proceedings.

"'A trial court has inherent discretionary power to impose sanctions for failure to make discovery, subject only to the requirement that they be just and reasonable in the circumstances.'" Abtrax Pharm., Inc. v. Elkins-Sinn, Inc., 139 N.J. 499, 513 (1995) (quoting Calabrese v. Trenton State Coll., 162 N.J. Super. 145, 151-52 (App. Div. 1978), aff d, 82 N.J. 321 (1980)). A decision to impose discovery sanctions is reviewed under the abuse of discretion standard. Id. at 517.

Rule 4:23-2(b) provides for various remedies available to the court to address a party's failure to comply with discovery orders. Accordingly, a court may execute

(1) An order that the matters regarding which the order was made or any other designated facts shall be taken to be established for the purposes of the action in accordance with the claim of the party obtaining the order;

 

(2) An order refusing to allow the disobedient party to support or oppose designated claims or defenses, or prohibiting the introduction of designated matters in evidence;

 

(3) An order striking out pleadings or parts thereof, or staying further proceedings until the order is obeyed, or dismissing the action or proceeding or any part thereof with or without prejudice, or rendering a judgment by default against the disobedient party;

 

(4) In lieu of any of the foregoing orders or in addition thereto, an order treating as a contempt of court the failure to obey any orders.

In lieu of any of the foregoing orders or in addition thereto, the court shall require the party failing to obey the order to pay the reasonable expenses, including attorney's fees, caused by the failure, unless the court finds that the failure was substantially justified or that other circumstances make an award of expenses unjust.

 

[Ibid.]

 

The Supreme Court has provided guidance in determining whether to impose an ultimate sanction, such as the dismissal of a party's claims or the suppression of defenses:

In respect of the ultimate sanction of dismissal, this Court has struck a balance by instructing courts to impose that sanction only sparingly. The dismissal of a party's cause of action, with prejudice, is drastic and is generally not to be invoked except in those cases in which the order for discovery goes to the very foundation of the cause of action, or where the refusal to comply is deliberate and contumacious. Since dismissal with prejudice is the ultimate sanction, it will normally be ordered only when no lesser sanction will suffice to erase the prejudice suffered by the non-delinquent party, or when the litigant rather than the attorney was at fault. Moreover, the imposition of the severe sanction of dismissal is imposed not only to penalize those whose conduct warrant it, but to deter others who [might] be tempted to violate the rules absent such a deterrent.

 

[Abtrax, supra, 139 N.J. at 514-15 (alteration in original) (citations and internal quotation marks omitted).]

 

Here, the motion judge stated that the sanctions were imposed because defendants had refused to turn over the QuickBooks records for almost a year. The judge found that this "spoliation" of evidence warranted the harsh sanctions imposed. However, the record does not support the judge's conclusion that "spoliation" occurred in this case.

The controlling legal principles are clear. A spoliation claim arises when a party in a civil action has hidden, destroyed, or lost relevant evidence and thereby impaired another party's ability to prosecute or defend the action. Rosenblit v. Zimmerman, 166 N.J. 391, 400-01 (2001); Manorcare Health Servs., Inc. v. Osmose Wood Pres., Inc., 336 N.J. Super. 218, 226 (App. Div. 2001). Here, the QuickBooks records were not produced for approximately one year, despite Liberty Mutual and the State's repeated discovery requests for electronically stored information. However, the records were eventually provided, intact, to plaintiffs. Liberty Mutual and the State were able to use the records at depositions, in the preparation of expert reports, and at trial. As the Supreme Court held in Rosenblit, where the party seeking the discovery ultimately receives it, either from the recalcitrant party or from another available source, a spoliation order or inference is not appropriate. Rosenblit, supra, 166 N.J. at 411. Therefore, we are constrained to conclude that the judge mistakenly exercised her discretion in entering a spoliation order against defendants.3

To be sure, sanctions were appropriate due to defendants' failure to timely provide the QuickBooks records. However, selection of the remedy "that is appropriate under the circumstances must be guided by the essential purposes that all of the sanctions are designed to achieve." Robertet Flavors, Inc. v. Tri-Form Constr., Inc., 203 N.J. 252, 273 (2010). One of these goals is to make the aggrieved party "'whole, as nearly as possible.'" Ibid. (quoting Rosenblit, supra, 166 N.J. at 401). If the prejudice against a party by the failure to timely make discovery can be eliminated, and the parties again placed on an equal playing field, sanctions other than dismissal of claims or defenses to specific counts of a complaint should be imposed. Id. at 273-74.

Here, the motion judge did not consider the possibility of imposing any lesser sanctions in her brief remarks at the conclusion of the motion hearing. Neither Liberty Mutual nor the State demonstrated that they were prejudiced by defendants' failure to turn over the QuickBooks records when they were initially sought. While they incurred attorneys' fees and costs, the judge ordered that these expenses be paid by defendants. By "rectifying the prejudice" in that fashion, the parties were again placed "in equipoise." Robertet Flavors, supra, 203 N.J. at 273 (quoting Hirsch v. Gen. Motors Corp., 266 N.J. Super. 222, 266 (Law Div. 1993)). Under these circumstances, we conclude that the motion judge's entry of the additional provisions of the September 11, 2009 orders, which required that verdicts be entered against defendants for workers' compensation, insurance, and common law fraud, was a mistaken exercise of discretion.

The spoliation orders entered by the judge formed the linchpin for everything that followed, including plaintiffs' successful summary judgment motions and the final judgments entered following the trial. Accordingly, we reverse these judgments and remand for further proceedings.

Reversed and remanded. We do not retain jurisdiction.

1 The record contains no intervening complaints between Liberty Mutual's original complaint and its fourth amended complaint.

2 The terms of the settlement were not disclosed to defendants and are not part of the record on appeal.

3 Liberty Mutual and the State argue that defendants did destroy evidence because, at his May 4, 2009 deposition, Day Senior admitted that he threw out his home computer, which he used for e-mail, after it "totally broke down." Therefore, they argue that there was a basis for the spoliation orders. However, the motion judge made no findings concerning this computer, including whether it contained any information related to the current litigation. Therefore, this argument must be rejected.